The European Union should develop a regulatory framework for environmental, social and governance ratings according to EFAMA, the European Fund and Asset Management Association.
The market for ESG ratings has grown following the introduction of two ESG-related fund categories, Article 8 and 9, in the Sustainability Financial Disclosure Regulation (SFDR).
EFAMA analysed ESG ratings from Refinitiv and Morningstar Direct for a large sample of Article 8 and 9 funds in a report, “ESG ratings of Article 8 and 9 funds: assessing the current market and policy recommendations for the future.” The research looked at differences between ratings given to the same funds by these firms and between ratings of Article 8 and Article 9 funds.
The research found there is a positive correlation between ESG ratings provided by Morningstar and Refinitiv, but it is quite small.
“Many funds with a low Refinitiv score do well in the Morningstar ratings and vice versa,” said the report. “This is not too surprising because rating agencies base a fund’s ESG rating on their own proprietary assessment and these ratings bear little relationship with the SFDR classification.”
As a result EFAMA recommended that funds, advisors and distributors should not use ESG ratings, or Article 8 or 9 status, in isolation. In order to understand ESG characteristics they should use additional tools, including the European ESG Template (EET), national and international guidance, consulting services, and precontractual and periodic reporting.
The trade body also recommended that the EU should develop a regulatory framework for ESG ratings to impose disclosure of the methodologies and data sources used to provide ratings; to provide a level playing field by ensuring that all major firms assigning ratings to funds domiciled in the EU are within scope and to preserve market integrity by setting specific requirements for internal controls and governance processes to avoid conflicts of interest.
“Supervisory authorities should gain a good understanding of the pricing and licensing frameworks involved to ensure a competitive market for ESG ratings that does not allow a small number of providers to set excessively high fees for their services,” said EFAMA.
In the meantime a voluntary code of conduct could be developed to provide valuable insight for the future legal framework.
Tanguy van de Werve, Director General at EFAMA, said in a statement that the use of ESG ratings for funds is expected to grow rapidly as investor demand for ESG funds increases, so the ratings market needs to function well and provide transparency.
“As the European Commission is currently considering a regulatory framework for ESG ratings, now is the right time to make sure that we have a market that is transparent and competitive, which will help channel investment where it is needed most for Europe’s transition to a climate-neutral economy,” added van de Werve.
